1. Assume that due to a recession, Polaski Company expects to sell only 36,000 R

Question

1. Assume that due to a recession, Polaski Company expects to sell only 36,000 Rets through regular channels next year. A large retail chain has offered to purchase 6,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 6,000 units. This machine would cost $12,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order?

2. Refer to the original data. Assume again that Polaski Company expects to sell only 36,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 6,000 Rets. The Army would pay a fixed fee of $1.60 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 42,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 6,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 42,000 Rets per year. Costs associated with this level of production and sales are given below: Unit $ 25 Total Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Variable selling expense Fixed selling expense Total cost $ 1,050,000 252,000 126,000 294,000 168,000 252,000 $ 2,142,000 $ 51 The Rets normally sell for $56 each. Fixed manufacturing overhead is $294,000 per year within the range of 36,000 through 42,000 Rets per year Required: 1. Assume that due to a recession, Polaski Company expects to sell only 36,000 Rets through regular channels next year. A large retail chain has offered to purchase 6,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75% However, Polaski Company would have to purchase a special machine to engrave the retail chain's name on the 6,000 units. This machine would cost $12,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? 2. Refer to the original data. Assume again that Polaski Company expects to sell only 36,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 6,000 Rets. The Army would pay a fixed fee of $1.60 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. What is the financial advantage (disadvantage) of accepting the U.S Army's special order? 3. Assume the same situation as described in (2) above, except that the company expects to sell 42,000 Rets through regular channels next year. Thus, accepting the U.S. Army's order would require giving up regular sales of 6,000 Rets Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Explanation / Answer

1)

Discounted selling price per unit = $56 x 84% = $47.04

Variable selling expense per unit = $4 x 25% = $1 per unit

Fixed manufacturing overhead and fixed selling expenses will remain same under both optiotions as the fixed costs remain same within the relevant range of 36000 units to 42000 units.

2) The army will offer all the variable and fixed manufacturing costs and selling expenses will not be required. Moreover fixed selling expenses will also not change, even after selling another 6000 units to the army, as the company presently has underutilised capacity and increase of production by another 6000 units will not increase either the fixed manufacturing overhead or fixed selling overhead as total production will be within the relevant range of production of 36000 units to 42000 units. Therefore net contribution per unit to the company will be $1.60 per unit and the total advantage of taking the offer is 6000 x $1.60 = $9600

3)

Net disadvantage = $74400

Note:

Thye fixed expenses will remain same as in either case, the total production of the company will be limited to 42000 units.  

Units to be sold    6000 Selling price per unit $ 47.04 Sales Revenue $ 2,82,240 Less: Variable Expenses Direct material @ $25 per unit $ 1,50,000 Direct labour @ $ 6 per unit $     36,000 Variable manufacturing overhead @$7 per unit $     42,000 Variable selling expense @ $1 per unit $       6,000 Total variable expenses associated with the special offer $ 2,34,000 Contribution $     48,240 Cost of the additional machine $     12,000 Increase in operating income if the special offer is accepted $     36,240

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